Essay: The real problem with capitalism is the markets

IN RECENT weeks the newspapers have been full of the world financial crisis. Experts have seriously wondered whether it will lead to a global recession, even another Great Depression. Underlying that question is an even deeper one: will the new globalism that arose from the ruins of Communism and statism in the Eighties have an even shorter life than the old globalism that perished in the First World War and the dole queues of the Thirties?

The idea that the last two decades of the 20th century have reconnected our century with its first decades is natural, but also tantalising. The century starts and ends – here I quote from a recent book by Daniel Yergin and Joseph Stanislaw, “with markets ascendant and an expanding global economy, buttressed by a spirit of optimism”. In between, the world economy, under the impact of war and depression, is fractured into economic and ideological blocs, with a consequent shrinkage of the area of political and economic freedom.

The conjoining thesis rests on two inescapable facts. For the first time since 1914 it is not absurd to talk about a single world economy. The huge reconnecting event was, of course, the collapse of Communism. But the world of what is called the “emerging markets” embraces not just the former Communist countries, but large slices of Latin America and sub- Saharan Africa as well. The second reconnecting fact is the lack of ideological conflict. Of the ideologies that have torn this century apart, only capitalism is left, if it can be called an ideology. There are, of course, many different varieties, and much talk of Third Ways; but classic socialism is a busted flush. We can argue about whether the world today is more or less global than it was, say, in 1914. Different indicators give different results. We would not, in any case, expect a literal going back.

Contemporary crystal-ball-gazers divide into two camps – optimists and pessimists. Francis Fukuyama is the best known of the former. His thesis, first proclaimed in The End of History in 1989, is that our age is unique in having actualised universal markets and universal democracy. This, to him, is a guarantee that the future will transcend the past. It is a peculiarly American vision. However, in his most recent writings he has been arguing that America itself is in the throes of social crisis, largely owing to the breakdown of the family. So his optimism is, to that extent, becoming increasingly qualified. The pessimists are legion, but perhaps the best known – or at least closest to home – is John Gray. Gray’s central argument is that the free market order is bound to destroy society, and will therefore produce catastrophe. His specific target is globalisation. Global bond markets have knocked out the possibility of social market economies, committed to full employment, welfare provision and social cohesion. “All social democratic theories of justice,” he writes, “presuppose a closed economy.”

There is nothing new about either the optimistic or the pessimistic script. The optimists of the 19th century looked to free trade to unite the world and – in Prince Albert’s words – to “make an end of war after Christianity had tried and failed”; while according to Karl Marx the interdependence of nations would bring about “uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation”. Both scripts involve the fundamentally problematic relationship between market capitalism and society. For Fukuyama, the commercial interdependence of nations is humanising and pacifying; whereas Gray articulates the widespread feeling that the relentlessly dislocating demands of a market-driven order are inimical to human well-being.

This is a far more fundamental criticism of a free market system than that it is unjust – the socialist point. Karl Polanyi expressed the essence of this thought in his book The Great Transformation (1944): “To expect that a community would remain indifferent to the scourge of unemployment, the shifting of industries and occupations and… the moral and psychological torture accompanying them, merely because the economic effects in the long run might be beneficial, was to assume an absurdity.” The point is that capitalism is still at it. The revolutionising, dislocating process, with the social strains it brings in its train – as early as 1848 Marx noted its tendency to dissolve all family and religious ties, to “strip of its halo every occupation hitherto honoured” – is in full swing today. What 20th-century history has shown is that this process does not pauperise the worker, as Marx thought it would, but constantly enlarges the numbers of the affluent as more and more people and countries move up the income scale. So Marx’s own solution, the revolution, has been cut off, leaving his problem unsolved.

The latter-day pessimist, who rejects the delusive promise of the globalist Utopia, but is denied the consolations of the socialist one, is left bereft of hope. John Gray concludes, logically enough from his point of view: “We stand on the brink not of an era of plenty that free-marketeers project, but a tragic epoch, in which anarchic market forces and shrinking natural resources drag sovereign states into ever more dangerous rivalries. A deepening international anarchy is the human prospect”. However, before preparing ourselves for doomsday, we need to ask a basic question: was it the stresses and strains of capitalist civilisation that brought about the wars, revolutions and economic breakdowns of the 20th century, or something else? It is important to remember that the pacifist, progressive perspective of the 19th century was underpinned by the spread of responsible government. In this world view, the spread of commerce and the spread of democracy were as closely yoked together as were war and autocracy on the other side. From this perspective, the First World War, which started the 20th-century rot, had little to do with the dislocating effects of capitalist civilisation, and a great deal to do with the persistence of autocratic rule in central and eastern Europe.

Marx’s idea – taken up by Gray and the new communitarians – that the market destroys society, is also highly overwrought. The United States has been the most capitalist nation in the world. But it has also been one of the most religious and family- and community- minded. Contemporary east Asia also refutes the idea that capitalism destroys social cohesion. A sensible conclusion from the 20th-century record is that it’s not the stresses and strains of capitalist civilisation that produce a flight from the market, but economic instability. We are currently experiencing the truth of this. If the instability is too great, political support for free exchange ebbs away, and societies can become renationalised and remilitarised – as happened in the Thirties.

The trick today is, as it has long been, to combine the restlessness of capitalism with a modicum of stability. Specifically, we need to avoid the economic equivalent of earthquakes. This is where Keynes comes in – or rather, comes back. Keynes developed a logical theory of economic earthquakes in terms of shocks to confidence that cause wealth owners to hoard money rather than invest it. The heart of the instability lay in the financial institutions of advanced capitalist civilisation – that nexus of banks, stock markets and money markets that supplied industry with its investment funds, but that could be “shocked” into withholding them. If the financial system as a whole did a “bear” on the economy, production could run down to a very low level and stay there until something happened to revive investors’ confidence – which might take a long time. The government’s job was to prevent such a meltdown; to lean against any tendency to hoard by pumping money into the economy, like pumping air into a deflating balloon.

This insight by Keynes into the causes and consequences of financial crises remains supremely valuable. But the policy implications of it are not as simple as they seemed in the aftermath of the Great Depression of the Thirties. In the Sixties and early Seventies governments pumped up balloons that were already too full of air, unleashing world-wide inflation and many associated disorders that discredited the system of Keynesian economic management. The result was to bring the “hard money” men back into power. Governments embarked on a necessary, but costly, course of disinflation – letting the air out of the balloon. At the same time the view gained ground that the sole source of the problem of instability lay with governments. Markets themselves were efficient; it was governments that were inefficient. Therefore let markets – and particularly financial markets – rip, and everything would be all right.

Since this doctrine took hold in the Eighties we have lived in a boom and bust world tempered by large and expensive rescue packages, with the experts repeating like parrots that markets were efficient and that it was governments that were to blame. Even today the predominant mood is to blame the governments of east Asia and Russia for the calamities that have befallen their countries, rather than the international speculators who pulled the rug from under their economies. The answer is that governments can, and do, make all kinds of mistakes, through corruption or ignorance, but that financial markets can be equally wayward, for the same reasons. In particular, they suffer from the herd instinct brilliantly analysed by Keynes, not just because they are slaves to fashion, like most of us, but because when financial assets start haemorrhaging in one market, it is very hard to stop the blood spilling out across the whole system. When this happened in the Thirties, the leading powers broke up the global economy to protect themselves.

The emerging wisdom is that reasonable stability in a decentralised economic system requires two sets of rules of good behaviour – for governments and for financial markets. The governments of most countries are already pretty well hedged in with both monetary and fiscal rules, which they accept as entry tickets to the world economic game. (Such rules are subject to override provisions for emergencies, as they always have been.) With the unique, and tragic, exception of Russia it is hard to blame the current crisis on state mismanagement of fiscal or monetary policy. The banking and financial sector, though, is completely out of control, and this is where the danger now lies, because it is here that crises of confidence have their source. When Keynes and his colleagues devised a financial architecture for the post-war world at Bretton Woods in 1944 they insisted on two sets of rules: rules governing changes in exchange rates, and rules governing the international movement of capital. They considered that the main currencies should normally be fixed in relation to each other, with changes subject to the approval of the International Monetary Fund. They also urged retention of the wartime machinery of capital controls, the aim being not to discourage foreign investment, but to distinguish between foreign investment and speculation. They thought that both (together with the adjustment facility provided by the IMF itself) were necessary conditions for restoring a liberal trading system.

The IMF remains, but the other two conditions have long since disappeared. Their absence lies at the root of the succession of financial crises that has plagued the world since the Eighties. The east Asian financial meltdown illustrates most dramatically the cost of the present hotchpotch of floating and pegged currencies that make up today’s non-system, and especially the connection between speculation and currency volatility. Writing in 1941, Keynes called floating exchange rates a “failed experiment”. This failure has been doubly confirmed. He was equally prescient about capital movements. Contrasting the flow of investment capital in the late 19th century with the speculative flows of the inter-war years, he wrote: “We have no security against the repetition of this after the present war… The whereabouts of `the better ‘ole’ will shift with the speed of a magic carpet. Loose funds may sweep round the world, disorganising all steady business.” Even George Soros would say “amen” to that.

Today the academic case for floating exchange rates and unregulated capital movements is seriously undermined. The obstacle to setting up new rules covering both lies less in their desirability than in the feasibility of doing so and – it must be admitted – in disagreement about the rules required. Yet to continue without rules is to risk the destruction of the free market over much of the world – and a 21st century that will resemble the worst of our own rather than the best of the 19th.